The Fed Blog

Tuesday, November 26, 2013

My bullishness since March 2009 has been driven by rising earnings. The rebound in S&P 500 forward earnings was V-shaped from 2009 through mid-2011, breaking out to new highs during May 2011. It’s been making new highs ever since then. In November, it was at $120.55 per share, up 92% from the cyclical low of $62.92 during May 2009.

Forward earnings, which is the time-weighted average of consensus operating earnings for the current year and next year, is a very good year-ahead leading indicator of actual earnings over the next four quarters So there's a good chance that the S&P 500 will earn about $120 per share in 2014, which coincides with my forecast.

That forward earnings number is currently in the market with the forward P/E at 15, up from about 10 during the summer of 2011. That was a retest of the P/E low in March 2009. Forward earnings are also at record highs for the S&P 400 MidCaps and S&P 600 SmallCaps with their respective forward P/Es at 16.9 and 18.5.

Today's Morning Briefing: Thanksgiving. (1) Counting our blessings. (2) Thanks to Tom Hanks. (3) Symbology and strategy. (4) From 666 to 1802. (5) Is there any meaning in 777? (6) Since March 2009, forward earnings up 83%, P/E up 45%. (7) Net Earnings Revisions Indexes are mostly negative around the world. (8) NERI dives in France and runs out of mojo in Tokyo. (9) NERI upticks in China and India. (10) Focus on market-weight-rated housing-related stocks. (More for subscribers.)

Monday, November 25, 2013

The nuclear deal signed on Sunday with Iran will not allow any more Iranian oil into the market, nor let western energy investors into the country. However, it does freeze US plans for deeper cuts to Iranian crude exports. "In the next six months, Iran's crude oil sales cannot increase," according to a fact sheet posted by the White House on the US State Department's website on Sunday.

US sanctions effectively bar Iran from repatriating earnings from oil exports, forcing customers to pay into a bank in their country. Washington estimates that Iran has around $100 billion in foreign exchange earnings trapped in such accounts. Under the terms of the deal, Iran will be allowed access to $4.2 billion of oil export revenues. But nearly $15 billion still will flow into accounts overseas over the next six months, according to the US government.

Nevertheless, if the interim agreement is setting the stage for a diplomatic resolution of the Iran nuke issue, then the price of oil could drop even before sanctions are completely removed. The price of a barrel of Brent crude oil jumped $3.36 to $111.95 last week on pessimism about a deal getting done. It could tumble on expectations of a rebound in Iran’s crude oil exports, which plunged by more than one million barrels per day since sanctions were imposed in early 2012.

Of course, Libya’s oil output has also dropped over the past few months as a result of the anarchy caused by numerous rival militia groups. Nevertheless, world crude oil supplies rose to a new record high of 90.9mbd during October, led by a sharp increase in non-OPEC production in recent months. The combined output of the US and Canada rose to a record 11.5mbd during October, exceeding Saudi Arabia’s output of 9.5mbd.

These developments should put a lid on energy inflation. In the US and Europe, CPI energy inflation rates, on a year-over-year basis, were -4.8% and -1.7%, respectively, during October. The price of gold continued to slide last week, suggesting that other commodity prices may also remain weak.

Thursday, November 21, 2013

To taper QE, or not to taper QE? That is the question. Another question is why haven’t the members of the FOMC considered tying QE tapering to the tapering of the federal deficit? Over the past 12 months through October, the federal deficit has totaled $652 billion, or $54 billion per month on average. That’s down from the $88 billion per month average during December 2012, when the FOMC decided to purchase $45 billion per month in US Treasuries.

Given that the federal deficit has narrowed by about 40% since last December, why not taper Treasury purchases by the same amount to $27 billion per month? That would be a credible, obvious, and easy way to sell tapering. Instead, Fed officials are subjecting us to their tiresome dramatics over an initial tapering that probably won’t be any bigger than $10 billion to $15 billion per month.

It would make sense for the FOMC to taper QE purchases of Treasuries as the federal deficit narrows. However, Fed officials don’t want to admit that QE amounts to monetizing the federal debt. They prefer to say that they are striving to achieve the mandate of full employment and low inflation set for them by Congress.

Wednesday, November 20, 2013

The Oil Market Intelligence (OMI) group tracks monthly global oil demand. I track the 12-month moving averages of their data to smooth out the monthly volatility. Total world demand rose to a record 91.1mbd during October. However, that’s up at a rather anemic pace of 1.3% y/y. The OMI data show that demand in the 34 advanced economies of the OECD fell 0.3% y/y last month. The growth rate among non-OECD countries has been slowing since January, from 3.8% to 3.0% during October.

By the way, so far, it’s hard to see any positive impact of Abenomics on Japan’s oil demand, which has been falling for the past nine consecutive months through October. Electric power consumed by large producers rebounded earlier this year, but fell sharply during August and September.

Tuesday, November 19, 2013

It’s good to see that the US economy continues to be an important source of strength for the global economy. Over the past few years, there has been a close correlation between the CRB raw industrials spot price index and the S&P 500 Transportation Index. Since the summer of 2012, the former has been relatively flat, while the latter has gone on to make numerous new record highs during 2013.

I view the commodity index as a sensitive indicator of global economic growth that has been especially sensitive to the pace of growth in China. The Transportation Index tends to be a more US-centric economic indicator. Its bullishness is confirmed by railcar loadings. Total loadings rose to a cyclical high in early November. Intermodal loadings rose to a record high. The ATA Trucking Index also rose to a new record high in September.

Not surprisingly, the forward earnings of the S&P 500 Transportation Index rose to a new record high in mid-November. The same can be said for the forward earnings of the S&P 500 Railroads industry, which accounts for 45% of the market cap of the Transportation Index. The fact that forward earnings is also at a record high for S&P 500 Air Freight & Logistics suggests that the global economy is not as weak as suggested by the flat trend in global exports. Of course, the recent weakness in oil prices is also a bullish development for transportation stocks.

Monday, November 18, 2013

Presumably, among the risks of QE are speculative debt-financed asset bubbles. However, last week, Janet Yellen said, “At this point, I don't see a risk to financial stability, although there are limited signs of a reach for yield.” She said that based on current valuations, stocks aren’t “in territory that suggest bubble-like conditions.”

I see more bubble-like conditions than Janet Yellen does. Her lack of concern may be justified currently, but by expressing it she increases the odds of triggering melt-ups in asset markets, especially if she turns out to be even more dovish than Bernanke, as I expect. Consider the following:

(1) Emerging market debt. The result of the widespread “reach for yield” is that debt sales by emerging markets rose to $439 billion this year through October, within reach of last year’s record of $488 billion. According to the 11/6 FT articleon this subject, “record debt sales from the developing world have rebounded after a summer of turmoil and the US budget crisis stunted demand, leading analysts and bankers to predict the second record year of bond issuance in a row.” Tapering chatter during the summer nearly burst the bubble in emerging market debt. Since the 9/18 decision not to taper, more air has been pumped into it.

(2) Corporate bonds. The Fed’s Flow of Funds data show that the outstanding amount of corporate bonds issued by nonfinancial corporations rose to a record $6.1 trillion at the end of Q2-2013. That’s up by a record $625 billion y/y. That may not seem like a bubble since corporations may be using some of the proceeds to reduce their short-term debts, and have lots of liquid assets. However, corporations also are likely to be using some of their bond proceeds to buy back shares, which artificially inflates earnings per share. That’s a bubble-like development if stock prices are getting a significant lift from debt-financed share buybacks rather than actual earnings growth.

Today's Morning Briefing: Party On, Dudes! (1) Yellen and Gatsby. (2) Yellen is in no rush to taper. (3) Benefits outweigh the costs of QE for now, she said. (4) No bubble in stocks, she said. (5) Bull following lead of FOMC’s doves. (6) Record bond issuance as investors reach for yield. (7) Yellen’s first press conference on March 19 should be bullish. (8) Yellen may have to nurse economy from Obamacare disaster. (9) Yellen stocks. (10) “Dallas Buyers Club” (+ +). (More for subscribers.)

Thursday, November 14, 2013

The information technology industry is one of the most competitive in the world. Creative destruction is its modus operandi. Given my interest in the knowledge economy, I am closely tracking the key metrics of the World Information Technology Sector MSCI. The bad news is that forward revenues actually peaked during 2012 and have been gradually declining since then. The cannibalization of PCs by smartphones and Cloud computing can explain the recent weakness in revenues.

The good news is that while sales and margins have been dropping in the PC industry, IT companies with higher margins are doing well, as evidenced by the forward profit margin of the global IT sector. It has actually been rising to new record highs since 2012.

As a result, forward earnings of the global IT sector edged up to a new record high during the first week of November. The forward P/E of the sector is 13.9, matching the valuation multiple of the World MSCI. That’s the cheapest relative valuation of the sector since 1995!

Today's Morning Briefing: Structural Problems. (1) Cyclical or structural? (2) Unconventional is turning conventional. (3) Great for asset holders, not so for job seekers. (4) Drowning in liquidity. (5) Lots of reasons for subpar growth. (6) The downside of the knowledge economy. (7) Brains putting brawn out of work. (8) Record-high spending on knowledge capital. (9) Margins rising for World IT MSCI, and the index is cheap. (10) Euro zone stocks discounting a recovery that may be weaker than expected. (More for subscribers.)

Wednesday, November 13, 2013

I think that the 10-year Treasury yield could be in a trading range between 2.5%-3.5% through 2014 and maybe beyond. That’s mostly because I think that inflation is dead, and likely to flat-line around 1% for the foreseeable future. My “Bond Vigilantes” model for the bond yield simply compares it to the y/y growth rate in nominal GDP.

This model shows that since 1953, the yield has fluctuated around the growth of GDP. They both tend to be volatile. As a result, they rarely coincide. When they diverge, the model forces us to explain why this is happening and can reveal important inflection points in the relationship. Here’s a brief history of this relationship:

(2) That changed during the 1980s when investors belatedly turned much more wary of inflation, just as it was heading downwards. Nevertheless, the yield tended to trade above the growth in nominal GDP. The July 27, 1983 issue of my commentary was titled, “Bond Investors Are The Economy’s Bond Vigilantes.” I concluded: “So if the fiscal and monetary authorities won’t regulate the economy, the bond investors will. The economy will be run by vigilantes in the credit markets.”

(3) During the 1980s and 1990s, there were several episodes where rising bond yields slowed the economy. The heydays of the Bond Vigilantes were during the first term of the Clinton administration, which adopted policies aimed at placating them. Indeed, Clinton political adviser James Carville said at the time that “I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody.”

(4) During the previous decade, the Fed kept the federal funds rate too low for too long mostly on fears of deflation. As a result, bond yields remained mostly below nominal GDP growth. Mortgage rates and mortgage lending standards were too low. The result was a huge bubble in housing, which led to the Great Recession.

(5) Over the past five years, the Fed’s response to the anemic recovery following the Great Recession has been to peg the federal funds rate near zero and to purchase bonds. The Bond Vigilantes were buried by the Fed’s ultra-easy policies. However, the Bond Zombies rose from the dead during the spring and summer! The yield rebounded back close to the growth rate of nominal GDP, which was 3.1% during Q3.

Today's Morning Briefing: New Normal Is Bullish. (1) Hit-and-miss ultra-easy monetary policy. (2) Getting back to business. (3) PIMCO’s spin on the new “new normal.” (4) Ambiguous advice. (5) A brief history of the “Bond Vigilantes” model of the bond yield. (6) Bond Zombies. (7) The Fed was horrified. (8) Where is the exit door? (9) Before and after 2008. (10) Signs of life in World-ex US revenues. (11) OECD leading indicators looking good for advanced economies, and not so good for BRICs. (More for subscribers.)

Tuesday, November 12, 2013

Fed officials have said that their ultra-easy monetary policy is justified not only by weakness in the labor markets but also by declining consumer price inflation, especially if it gets too close to deflation. They’ve indicated that even if the unemployment rate falls down to 6.5%, they might be in no rush to tighten policy if inflation remains too low.

While Friday’s employment report received lots of attention, the inflation data in the personal income report were mostly overlooked. The personal consumption expenditures deflator excluding food and energy (a.k.a. the “core” PCED) was up only 1.2% y/y during September, which was also well below the core CPI inflation rate of 1.7%. The core PCED inflation rate has been below the Fed’s 2% target since October 2008 for all but four months in early 2012 (when it was around 2%).

While rent inflation has been trending higher since 2010, the inflation rates for hospital fees and physician services have declined significantly. The former is down to 1.5%, the lowest since December 1998, while the latter is down to zero, the lowest since February 2003. Why would the Fed possibly want to see these inflation rates move higher?

Monday, November 11, 2013

For now, the data show that real GDP on a y/y basis rose only 1.6%, continuing to grow just below the dreaded “stall speed” of 2%, as it has been since the start of the year. However, excluding government spending, it is up to 2.7% from Q1’s 2.1%, suggesting that the private sector may be resuming its relatively steady growth since mid-2010 around 3%.

There was some other encouraging news in the GDP report. While total real capital equipment spending edged down during Q3, industrial equipment spending jumped to a new cyclical high ($195bn saar), R&D spending rose to a new record high ($250bn), and software outlays remained around a record high ($297bn). One more cheery item: Exports rose to a new high, suggesting that the global economy continues to grow and to offer sales opportunities to US companies.

Thursday, November 7, 2013

What’s up in Europe? Forward P/Es are up a lot since the summer of 2011, when there were still widespread fears that the euro zone might disintegrate. Those fears evaporated one year later when ECB President Mario Draghi pledged to do whatever it takes to keep the euro zone intact. The forward P/E for the Europe ex-UK MSCI bottomed at 8.3 during the summer of 2011. It is now up to 13.6, matching the 2009 high.

The rebound in forward P/Es has been widespread among the major stock markets of the euro zone. They are mostly back to 2009 levels prior to when Greece hit late that year and early in 2010. In other words, investors no longer seem to be worrying about a “Grexit” or any other threat to the integrity of Europe’s monetary union. The question is whether there is more upside for the region’s valuation multiples.

I think there might be, but forward earnings, which has been flat-lining since 2011, as I noted yesterday, needs to show some signs of life. That, in turn, requires that European economic indicators show that the region’s economy hasn’t just bottomed, but is actually recovering. The latest batch of these indicators does show a recovery, but a slow-paced one that may already have been discounted by the rebound in valuation multiples.

Wednesday, November 6, 2013

Emerging markets, which account for 20% of the World ex US MSCI, have lost their earnings groove. The forward earnings for the EM MSCI rose to a new record high during 2009 through mid-2011. However, it stalled since then and continues to flat-line. As I’ve noted before, the forward earnings of EM MSCI has been highly correlated with the CRB raw industrials spot price index since the mid-1990s. The commodity index has been slowly losing altitude since the start of the year.

China accounts for 4% of the World ex-US MSCI, and 19% of the EM MSCI. The forward earnings of the China MSCI also flattened out around mid-2011, but it’s been edging up into record-high territory this year. Yesterday’s FT included a story titled, “Chinese manufacturers feel squeeze of stronger renminbi.” While that may be so anecdotally, the forward profit margin of the China MSCI actually might have started to bottom late last year.

Tuesday, November 5, 2013

As I noted yesterday, the US auto industry is leading a global rebound in manufacturing this year. However, sales remain below the previous cycle’s high pace. Yet both new orders and industrial production of motor vehicles and parts were in record-high territory during September.

Undoubtedly, the strength of the auto industry is contributing to the strength in new orders for both industrial machinery and metalworking machinery. The former is near previous cyclical highs, while the latter is in record-high territory.

On the other hand, machinery demand for construction and farming has been relatively weak recently. The same can be said of new orders for mining, oil field, and gas field machinery. All three tend to be very volatile on a monthly basis.

Today's Morning Briefing: Industrious Industrials. (1) Are companies short-sighted? (2) From “TMT” to “MEI” to “CFI.” (3) Capital goods orders stalled at cyclical high, but orders for factory machinery at record highs. (4) New tech revolution led by Cloud, Big Data, and GPS technologies rather than computer hardware. (5) Backlog of orders for civilian aircraft at record high. (6) Industrials are less volatile way to play global growth than Materials & Energy. (7) Yellen and Yale. (More for subscribers.)

Monday, November 4, 2013

Global industrial production rose to a new record high during August, and is up 2.6% y/y. So why has the CRB raw industrials spot price index been weak so far this year? I am starting to think that it may be a misleading indicator of the global economy. The commodity index was highly correlated with the production index from 2001-2011 during the so-called “commodity super-cycle.” It was super, but it was short, lasting only 10 years. Lots of capital was invested to increase the supplies of industrial commodities. It paid off in more supplies, but weaker prices. Even the recent weakness of the dollar doesn’t seem to be lifting commodity prices as it did in the past.

The same can be said for crude oil and gasoline. Earlier this year, the prices of both were bolstered by geopolitical tensions, which may be subsiding now--resulting in downward pressure on oil and gasoline prices. Of course, the recent decline in pump prices should provide a boost to US consumer spending.

Today's Morning Briefing: Driving the Global Economy. (1) Some positive surprises. (2) The weakness in industrial commodity prices may be misleading. (3) The end of the super-cycle already? (4) US business sales support 5% growth outlook for S&P 500 revenues. (5) Intermodal railcar loadings at record high. (6) Short-term business credit jumps to record high too. (7) Manufacturing expanding everywhere. (8) Global auto industry leading the pack. (9) Analysts turning more upbeat on global auto margins and earnings as investors boost valuation multiple. (10) “12 Years a Slave" (+ +). (More for subscribers.)

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ABOUT: Dr. Ed Yardeni is the President and Chief Investment Strategist of Yardeni Research, Inc., a provider of independent investment strategy and economics research. This blog highlights excerpts from our research service, which is designed for investment and business professionals.

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